Ever wanna learn more about these gigantic monsters that recently charged the US financial markets? Heres a pretty good start:
Published: October 31, 2007 in [email protected]
Oil is marching toward $100 a barrel, largely due to China’s boom. Demand for ethanol is pushing corn prices up. Soybean prices are rising because so many bean fields have been switched to corn. In short, prices of commodities worldwide are soaring, making for frenzied action in commodities futures markets, where traders buy and sell contracts setting prices to be paid months down the road.
Everyone knows that supply and demand govern prices. But much remains unclear about the subtleties of that interaction in the commodities markets — and about the best ways to wring profits from it. “Commodities futures are an asset class that has been under-researched compared to equities in particular,” says Wharton finance professor Gary B. Gorton.
New work by Gorton, Fumio Hayashi of the University of Tokyo and K. Geert Rouwenhorst of Yale, shows how investors can win bigger profits with futures-trading strategies based on the amount of a given commodity that is held in storage. Returns — or “risk premiums” — are bigger when low inventories make prices more volatile, Gorton and his colleagues conclude.
Over the period studied, 1990 through 2006, a trading strategy focusing on low-inventory commodities would have produced average annual returns of 13.34%, compared to 4.62% for a high-inventory strategy, and about 9% for an approach that did not take inventory levels into account. “What we show is that you get paid more if the risk is higher,” Gorton says.
Most importantly, the research shows how to gauge hard-to-measure inventory levels by looking at the relationship between prices on the futures market and the spot, or cash, market where commodities are bought for immediate delivery. When the spot price rises more than the futures price, traders can infer that the inventory level has fallen — and that the opportunities to earn outsized profits are especially good. The findings, which could be especially useful to institutional investors and commodities trading advisors (CTAs), are described in a paper titled, “The Fundamentals of Commodity Futures Returns.”
The new paper follows on Gorton and Rouwenhorst’s earlier work, which found that, over long periods, commodity returns are as high as those of stocks, while experts had long thought them to be lower. That work, described in a paper titled “Facts and Fantasies about Commodities Futures,” also concluded, surprisingly, that commodities are not as risky as stocks. “Part of what we’re doing is trying to understand the determinant of those returns,” Gorton says about the follow-up study. “We get much more specific… [to] see if we can explain what moves that risk premium around through time and on individual commodities.”
Another article to show that the end game will not be nice. Many have forgotten the bear market prior to this climb that lasted for 3 years.
Updated: 2007-01-26 16:54
A man surnamed Li pawned his 200-square-meter apartment worth over 1 million yuan (US$129,000) near Beijing Capital Airport for 800,000 yuan so he could invest in the stock market. He then pawned his stocks for 700,000 yuan and bought more stocks.
High-risk investment or reckless gamble? Either way, this strategy is becoming increasingly popular among the Chinese capital’s speculators.
“Our client, Mr Li, had initially bought the apartment for property investment but, without a suitable buyer, he turned to stock investment,” said Yang Jingkun, assistant manager of Beijing Huaxia Pawnshop.
“Every month around 10 stock investors mortgage their apartments for 600,000 yuan to 700,000 yuan in our pawnshop,” said Yan Xingnong, general manager of Minsheng Pawnbroking Co, in Beijing.
“One of them pawned three luxury apartments for a total of three million yuan,” Yan said.
Beijingers pawned their apartments for a total of 1.5 billion yuan last year and most of the money was poured into the stock market, according to China Securities Journal.
Considering the size of the returns, the risk appears huge. Pawnshops in Beijing offer loans worth 70 percent of the value of an apartment and charge a monthly interest rate of 3.2 percent. If an investor pawns an apartment worth one million yuan and his stocks yield a 50-percent profit, then he or she will still only earn 81,200 yuan a year.
As you’ve probably heard by now, today marks the 20th anniversary of the stock market crash of 1987, which yanked down the Dow Jones Industrial Average by 22% in a single day. I can hardly think of a better way to commemorate one of the most famous stories of irrational expectations that ended in calamity than to discuss the world’s frothiest, most overheated, and biggest waiting-for-trouble market: China.
The financial world is no stranger to bubbles. As we’ve seen with the stock market crash of 1929, the Nifty 50 in the early 1970s, Taiwan and Japan in the 1980s, the Nasdaq dot-com hoopla in 2000, and the real estate mania over the past seven years, there’s rarely a shortage of stupidity somewhere in the markets.
One belief that tends to characterize these bubbles is that “it’s different this time.” People justified the incredible surge in the Japanese Nikkei average because they knew electronics would change the way our world functioned. They justified the Nasdaq boom by saying the Internet would forever change the way people do business. In both cases, those people were right about the effects on our lives — but that didn’t justify the massive speculation that dominated the market.
Sure, the Chinese economy has a lot going for it right now. For the first time since economic restructuring began in the 1970s, growth is being fueled by the citizens — not the Communist government. Combine that with low interest rates, an increase in property values, growing corporate profits, and a sky-high personal savings rate … and, heck, maybe it is different this time, right?
Keep dreaming. Just as the day after Christmas used to depress me beyond belief, all excessively good things must come to an end.